U.S. stock fund and ETF styles for your 2014 buy list

Good years for stock investors often follow great years like 2013

SAN FRANCISCO (MarketWatch) — Investors in mutual funds and exchange-traded funds mounted a spectacular ascent of the U.S. stock market’s proverbial Wall of Worry in 2013, hiking an essentially uninterrupted path to record heights and the best gains since 1997.

But as 2014 begins, concern is growing that the wall will tumble as investors look to stocks with complacency and say “What, me worry?”

Widespread optimism would be troubling for market returns going forward, but understandable, after diversified U.S. stock funds rose a stunning 34.2% in 2013 on average, including dividends, in a year that was anything but average. These funds’ ETF counterparts fared even better, up 34.8%, according to preliminary data from investment researcher Morningstar Inc.

“To the extent that interest rates and volatility is suppressed, market returns are going to be reasonably positive,” says Art Steinmetz, president of OppenheimerFunds.

“The big gains are behind us,” adds David Rosenberg, chief economist and strategist at money manager Gluskin Sheff + Associates. “But unless we have multiple contraction or get earnings decline, my sense is that earnings will be OK” He says U.S. stock investors can expect about a 7% total return in 2014, in line with Wall Street’s consensus.

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Still, that’s a far cry from what investors enjoyed in 2013. Indeed, every broad stock-fund group that Morningstar tracks posted stellar results for the year, ranging from 31% for large-cap value funds to 41% for small-cap growth funds.

Resolution of Washington’s budget battles and the Federal Reserve’s decision to begin cutting back, or tapering, its economy-boosting bond-buying program lifted a cloud of uncertainty hanging over investors, and contributed to a fourth-quarter surge that tacked more than 9% on average onto stock funds and ETFs.

The best U.S. stock fund category in 2013 was small-cap growth, up 41% for the year, though its 8.1% fourth-quarter return trailed its large-cap peers by more than two percentage points. Lord Abbett Securities Trust Micro-Cap Growth Fund
LMIYX, -2.21%
led the group with a 78.6% yearly gain, followed by Oberweis Micro-Cap Fund
OBMCX, -1.53%
up 64.9%.

Go with the flow

“After the kind of year we’ve just had and with the breadth we saw, it’s not unusual to have another gain the next year but have it be moderate,” says Stuart Freeman, chief equity strategist at Wells Fargo Advisors.

Cyclical sectors will be important contributors to investment returns in 2014, he adds, especially now that business and consumer sentiment in both the euro zone and Japan are improving, and China is implementing proactive economic reforms in the face of slower economic growth.

To be sure, U.S. manufacturers are experiencing a 21st-century renaissance. Many analysts predict this “Made in the U.S.A.” theme could be a winner in 2014, and funds and ETFs with heavy exposure to the industrials sector stand to gain. The biggest and most briskly traded ETF is Industrial Select Sector SPDR
XLI, -1.73%

U.S. energy independence also contributes to industrial companies’ competitiveness. U.S. oil production in October exceeded imports for the first time in 18 years, according to the U.S. Energy Information Administration. The biggest energy-sector ETF, Energy Select Sector SPDR XLE
XLE, -1.41%
offers a broad portfolio of large-cap, U.S.-based energy producers and suppliers.

Funds that focus on large-cap stocks that are growing their dividend payouts also seem in good shape for the coming year. Stronger global growth is positive for large U.S. multinationals. Companies in the S&P 500, for example, generate almost half of their sales from outside of the U.S.

Plus, investors in 2014 shouldn’t underestimate the likelihood of a dovish Fed that gradually tapers its bond buying, continued low inflation, steadily growing corporate earnings, and a ramping up in capital spending — all of which further supports cyclical market sectors and the market overall.

Says Linda Duessel, a senior equity market strategist at mutual-fund giant Federated Investors, “It might be earlier innings in the economic recovery than people think.” Technology, energy and other cyclical mainstays, she adds, “will benefit as the marketplace believes that global growth is accelerating.”

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